This year the IRS has increased the maximum employee 401(k) contribution limit to $19,500 for 2021.
The situation is the same with catch-up contributions. Those represent the additional amount of contributions that you can make to a 401(k) plan if you are age 50 or older.
For 2020, that number has also increased to $6,500, from $6,000 the catch-up contributions in 2018 and 2019. That means the total contribution for plan participants 50 and older is now $26,000.
Every year, in October, the 401(k) contribution limits are reviewed, and – hopefully – recalculated higher based on inflation.
Contribution limits increase more during years when the inflation rate is higher, and less when it is lower, as it has been in the past few years. At times, there have even been concerns that the contribution limits might be reduced, based on a negative inflation rate.
Fortunately, however, that scenario has never played out, and the limits have either been increased slightly or left flat.
Everything you need to know about 401k contribution limits for 2020:
The chart below shows the base 401(k) maximum contribution, the catch-up contribution for employees age 50 and older, and the maximum allocation from all tax-sheltered retirement plans, from 2009 or 2020.
As you can see, the rate of increase over the past eleven years has typically moved at a snail’s pace. There has been only a $3,000 increase in the maximum contribution since 2009, and an even smaller increase in the catch-up contribution over the same space of time.
And as you can also see, contribution limits have stagnated in the past, such as 2009 through 2011, when they remain at $16,500 for three years in a row. Even more obvious is the lack of increase in the catch-up contribution for a full six years, when the amount remained at $5,500 from 2009 through 2014.
From 2009 through 2020, the maximum increased from $49,000 to $57,000. That’s an increase of $8,000 over 10 years, which works out to be over 2% per year.
|Year||401(k) Maximum||Catch-Up Contribution||Maximum Allocation|
For each year, the maximum allocation is increased by the amount of the allowable catch-up contribution (which applies to workers 50 and older). For example, for 2020, the maximum allocation is $63,500. That is the maximum allocation of $57,000, plus the $6,500 catch-up contribution.
The Contribution Limits Also Apply to Roth 401(k) Contributions
Contribution limits for Roth 401(k) contributions are the same as they are for traditional 401(k) contributions. That means you can contribute up to $19,500 per year to either a regular 401(k) plan, or a Roth 401(k) plan.
More likely, you will want to contribute to both, in which case you’ll have to allocate how much of the $19,500 limit will go into each part of your 401(k).
Not coincidentally, the 401(k) limits are virtually the same as the limits for both the 403(b) plan and the Thrift Savings Plan (TSP).
In addition, any employer matching contributions to the plans are not included in the employee contribution limits listed above.
Your employer can contribute a matching contribution that exceeds the $19,500 regular contribution limit, or even the combined $26,000 limit if you are age 50 or older. It is always a good idea to figure out whether a Roth 401k vs Roth IRA is best for you.
How Much You Should Contribute with the New Contribution Limits
The IRS determines whether or not to increase its contribution limits based on an annual basis. Sometimes changes in the Consumer Price Index (CPI) have been very small, like on the order of 2% per year. Congress prefers to increase contributions in increments of at least $500, which they did this year.
With the ability to increase your contributions by $500 in 2020, you may be wondering if you should. My answer is a resounding yes.
If you divide that amount into monthly contributions, you’re making only slightly smaller payments which will benefit you in the long run. Continuing to max out your 401k at this level is an ideal strategy,
Tips for Contributing to Your 401(k)
For most workers, the flat or level 401(k) contribution limits over the past three years isn’t the real problem. The real problem is a lack of employee participation. A large percentage of employees do not participate in a 401(k) plan, even though one is offered by their employer.
Note also that the median value of a 401(k) plan nationwide was just $103,700 in 2018, which means that 50% of employees have more than this number in their 401(k), but 50% had less. What’s more, workers in their 30s averages much less, at just $42,400 – and half had less.
That represents a single year of regular contributions, plus a little bit of investment income earned on it. Clearly then, 401(k) contribution limits are not the real culprit here.
The moral of the story is that the biggest single problem with 401(k) plans is that not enough people are participating, and based on the median 401(k) value, it’s also clear that the great majority of employees are not coming close to making the maximum contributions anyway.
Contribution limits have only been increased by $500 in four years, but $19,500 still represents a lot of tax-deferred savings potential. Do what you can to get as close to the maximum contribution possible, especially as you move closer to retirement.
Take Advantage of the Maximum Allocation
The biggest number on the chart above for each year is in the Maximum Allocation column. That is the maximum amount of money that you can contribute to all tax-sheltered retirement plans that you have available to you. It’s actually a more important factor than most people realize.
Despite the fact the high 401(k) contribution limits, the average person isn’t coming close to maximize their potential contributions to retirement plans of all types. The 2020 maximum allocation for all plans is a very generous $57,000, or $63,500 for workers 50 and older.
That’s the amount of money that you can contribute even beyond your 401(k) plan. You may able to make tax-deductible contributions to a traditional IRA, or non-tax-deductible contributions to a Roth IRA, if your income is within the limits for either plan.
Contribute to an IRA
Even if your income exceeds the threshold for a tax-deductible contribution – in addition to being covered by an employer plan – you can make nondeductible contributions to a traditional IRA, regardless of your income.
That may not get you a tax deduction, but it will enable you to put more money into a retirement plan where your investment earnings will accumulate on a tax-deferred basis.
A $6,000 IRA contribution, in addition to contributing $19,500 into a 401(k) plan, will increase your contribution to $25,500 per year (or $32,000 if you’re 50 or older).
But beyond IRAs, there are also several types of tax-sheltered retirement plans for the self-employed, including SEP and SIMPLE IRAs. If you have a side business, you can maintain these retirement plans for that business.
They will allow you to contribute more money into a tax-sheltered plan. You can go as high as $57,000 total, which gives you plenty of room to make more contributions.
Take Full Advantage of your 401k with Blooom
Aiming to make 401(k) planning more of a help and less of a headache, Blooom is an asset management software that steps in where your employer often falls short.
For instance, Blooom offers assistance with the following important tasks:
- Avoiding: unwanted hidden fees
- Evading: pesky account minimums
- Determining: accurate stock-to-bond ratios
- Assessing: whether your current plan meets your long-term retirement goals
- Shifting: full partnering responsibility to employee instead of employer
Assets in Management
The free 401(k) analysis tool provides managing suggestions you must pursue on your own; however, initiating a paid account grants Blooom permission to oversee your retirement account, and critical updates are made on your behalf.
However, since Blooom is only geared toward managing retirement plans sponsored by employers, investors holding other account types or seeking any comprehensive advice should pursue more personalized options.
What We Can Expect of Contribution Limits in the Future
The good news is that we have been in a prolonged time of low inflation. That’s good news in regard to the cost of living, even though it has kept a lid on maximum 401(k) contribution limits.
Since that seems to be a long-term pattern, we should probably expect several more years of either low or nonexistent increases in the contribution limits.
But that makes an even stronger case for maximizing the contributions that you make within the limits that we have, as well as investigating the possibility of contributing to the other retirement plans, such as IRAs or the various plans that are available for the self-employed.
We have to work within the limits that we have, and recognize that they are more than enough to help us reach our retirement goals. Those limits will allow us to do just that, even if they don’t increase significantly in the future.